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Taxing Multinational Companies in the 21St Century 237 Taxing Multinational Companies in the 21st Century 237 Taxing Multinational Companies in the 21st Century Kimberly A. Clausing, Reed College Abstract The corporate tax remains a nearly indispensable feature of the U.S. tax system, since 70 percent of U.S. equity income is untaxed at the individual level by the U.S. government. Yet taxing multinational companies presents policymakers with conflicting goals. Although lower tax rates and favorable regimes may attract multinational activity, such policies erode the corporate income tax as a revenue source. Unfortunately, the Tax Cuts and Jobs Act of 2017 did not resolve this policy dilemma. Despite big reductions in corporate tax revenue due to lower rates, the 2017 tax law does not adequately address profit shifting or offshoring incentives within the tax code, nor does it improve the competitiveness of United States–headquartered multinational companies. This chapter proposes a rebalancing of U.S. international tax policy priorities. Starting from current law, there are several simple changes that can raise corporate tax revenue and adequately address profit shifting and offshoring; these changes can be implemented almost immediately within the architecture of current law. In the medium run the United States should partner with other countries to pursue a formulary approach to the taxation of international corporate income. By dramatically curtailing the pressures of tax competition and profit shifting, such an approach allows policymakers to transcend the trade-off between a competitive tax system and adequate corporate tax revenues. There is widespread international recognition of these problems; the current Organisation for Economic Co-operation and Development/ Group of 20 process can serve as a steppingstone toward a fundamental rethinking of how we tax multinational companies in the 21st century. 238 Kimberly Clausing Introduction The U.S. system of taxing multinational companies is broken. It was broken before the 2017 tax legislation and it remains broken today. The U.S. corporate tax system raises less revenue than the revenue raised in peer nations, despite the fact that U.S. corporate profits are a historically high share of GDP. The international elements of our corporate tax system are mind numbing in their complexity. There is a clear tilt of the economic playing field toward earning income abroad rather than in the United States. The 2017 Tax Cuts and Jobs Act (TCJA) built on a flawed system and, in many respects, made that system worse. In some respects, the persistent dysfunction of our international tax system is unsurprising. Throughout the world policymakers have been put in an impossible position, facing serious pressures from international tax competition while also attempting to protect the corporate tax base. At the same time, multinational companies are more powerful than they have ever been. They command larger profits and larger market shares than in prior decades, control a large part of the economy, and undertake the vast majority of all international trade. This economic power makes these political actors difficult to resist, especially when companies raise concerns about competitiveness and threaten to take the tax base, investments, and jobs abroad. In many countries policymakers have responded to tax competition pressures by slowly and steadily lowering corporate tax rates and shifting more of the tax burden onto labor and consumption. These trends are troubling for a number of reasons. In a larger economic context of increasing economic inequality and a declining labor share of income, such tax policy trends risk both exacerbating income concentration and reducing possible public revenue sources. There are also risks to the larger integrity of income tax systems. In the United States the tax cuts of the 2017 tax law did not resolve the essential tension between making the United States a competitive location for economic activity and protecting the corporate tax base. The law sacrificed large amounts of corporate tax revenue without achieving much (if anything) in terms of competitiveness. At the same time, the system became even more complicated. Beginning from current law, there are simple changes that would rebalance our international tax system. In this chapter I suggest several useful steps that fit within the architecture of the current law. However, these proposals will be politically contentious, and companies will argue that Taxing Multinational Companies in the 21st Century 239 their competitiveness is being sacrificed in order to protect the corporate tax base. While such arguments are vastly overstated, a more-fundamental reform of the U.S. international tax system can put an end to the trade-off between competitiveness and tax base protection, allowing both to be achieved at the same time. This reform would tax multinationals on the basis of their global profits, which would be allocated to countries by the distribution of sales rather than by the ostensible distribution of profits. By moving toward a sales-based formulary system, the tax base will become insensitive to profit-shifting motivations, and policymakers can choose a corporate tax rate without worries about fierce tax competition or profit shifting. Formulary apportionment of corporate income has many advantages relative to the current system. It curtails conventional profit shifting, it is administratively simpler, it is suited to the global nature of business activity and the modern nature of economic value, and it can become the basis of a stable international tax regime. However, there are also implementation issues, and this system would benefit from efforts toward international consensus building. While such consensus need not be complete, the current political environment, while challenging in many respects, provides a better starting point for international cooperation than many other periods. At present many countries have shown the requisite political will to tackle this problem. The years ahead may provide a rare opportunity to push for an internationally coherent system. While other reform suggestions have many merits, they also have important drawbacks. The Organisation for Economic Co-operation and Development (OECD)/Group of 20 (G20) framework is too incremental; it is unlikely to fundamentally change the pattern of multinational company tax avoidance. The destination-based cash flow tax (DBCFT) is conceptually straightforward but comes with substantial practical problems, especially surrounding the necessity of a border adjustment tax. Residual profit split methods have key advantages but retain aspects of the current problems associated with the arm’s-length standard. Coordinated adoption of minimum taxes is promising, but it leaves open questions about the impact of non-adopting countries. Formulary apportionment will take work, but it stands the best chance for building an efficient and stable international tax regime. Like democracy, and like capitalism, formulary apportionment could be the worst possible system, except for all the others. 240 Kimberly Clausing The Challenge: Competing Policy Aims of Multinational Company Taxation Policy decisions regarding the taxation of multinational companies frequently expose a tension between two competing goals: first, enhancing the competitiveness of the location for multinational company activity; and second, protecting the corporate tax base as a revenue source. In most tax systems these goals are in tension. Countries making their tax system more favorable to multinational companies by lowering their tax rates, or by instituting favorable regimes for particular activities or companies, typically erodes their corporate tax revenues.1 On the other hand, raising additional revenue through the corporate tax— by raising rates, clamping down on international profit shifting, or other measures—risks reducing the attractiveness of the location for mobile multinational activity. While booked profits are far more tax sensitive than physical investment or employment, the latter activities also respond to tax incentives. Policymakers are particularly reluctant to be aggressive in their corporate tax collection efforts for fear of discouraging jobs or investment. Corporate tax rates have declined steadily among OECD countries since the mid-1980s: In 1985 the average statutory tax rate among OECD countries was 43 percent; in 2000 it was 30 percent; and in 2019 it was 21.7 percent. Arguably, corporate taxation has been inhibited by a prisoner’s dilemma situation. Absent coordination, countries have an incentive to lower their tax rates to try to gain tax base at other countries’ expense. But if countries were to coordinate, they could sustain higher tax rates and a similar distribution of economic activity. (The aggregate amount of investment is far less tax sensitive than investment in any particular location.) WHY TAX CORPORATE INCOME AT ALL? One seemingly simple solution to this dilemma is to merely give up on corporate taxation, and to move capital taxation to the individual (shareholder) level. However, this approach encounters several serious problems. First, the lion’s share (about 70 percent) of U.S. equity income goes untaxed at the individual level by the U.S. government, as shown in Burman, Clausing, and Austin (2017). It is unclear that there is political will to remove long-held tax preferences for endowments, pensions, retirement accounts, 529 accounts, and so forth, so this lack of individual-level
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